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Morningstar's Guide to Investing in Chinese …

Morningstar ETF Research July 2013. Morningstar's Guide to Investing in Chinese equities via ETFs Authors: Jackie Choy, CFA, ETF Strategist Ben Johnson, Director, Global Passive Fund Research Hortense Bioy, CFA, Director, European Passive Fund Research Patricia Oey, Senior Fund Analyst John Gabriel, ETF Strategist Morningstar's Guide to Investing in 2. Chinese equities via ETFs July 2013. Contents Executive Summary 3. The ABC's (and H's and P's) of Chinese Equity Investing 4. Accessing China around the World via ETFs 10. Putting Chinese Equity ETFs to Use 16. Don't Forget the Risks 19. 10 Frequently Asked Questions Regarding Chinese Equity ETFs 21. Appendix: Roster of Chinese Equity ETFs by Region/Country of Listing 23. 2013 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, Morningstar ), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely.

Morningstar ETF Research July 2013 Morningstar’s Guide to Investing in Chinese Equities via ETFs Authors: Jackie Choy, CFA, ETF Strategist Ben Johnson, Director, Global Passive Fund Research

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Transcription of Morningstar's Guide to Investing in Chinese …

1 Morningstar ETF Research July 2013. Morningstar's Guide to Investing in Chinese equities via ETFs Authors: Jackie Choy, CFA, ETF Strategist Ben Johnson, Director, Global Passive Fund Research Hortense Bioy, CFA, Director, European Passive Fund Research Patricia Oey, Senior Fund Analyst John Gabriel, ETF Strategist Morningstar's Guide to Investing in 2. Chinese equities via ETFs July 2013. Contents Executive Summary 3. The ABC's (and H's and P's) of Chinese Equity Investing 4. Accessing China around the World via ETFs 10. Putting Chinese Equity ETFs to Use 16. Don't Forget the Risks 19. 10 Frequently Asked Questions Regarding Chinese Equity ETFs 21. Appendix: Roster of Chinese Equity ETFs by Region/Country of Listing 23. 2013 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, Morningstar ), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely.

2 Certain information may be self-reported by the investment vehicle and not subject to independent verification. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use. Past performance is no guarantee of future results. Morningstar's Guide to Investing in 3. Chinese equities via ETFs July 2013. Executive Summary equity ETFs listed on various exchanges outside China, with a combined USD 28 billion in assets under management (AUM). Indices tracking Chinese equities are constructed quite differently from one another and as such have very In June 2012, when we first launched our research reports different historical risk/return profiles. These distinctions on Asian ETFs, we published a note entitled Picking the are particularly pronounced, between onshore and Right Chinese Dishes from the ETF Menu , where we offshore Chinese equity indices.

3 These differences are discussed the importance of understanding an ETF's especially evident amongst the offshore indices. Hence underlying exposure and the relevant fundamentals. In this it is crucial that investors closely scrutinise these indices Guide , we build upon our original work and look at what's to ensure that they choose the one that best matches on offer on the global menu of ETFs offering exposure to their investment thesis. Chinese equities as well as what investors should watch out for before making an investment decision. Distribution of Chinese equity ETFs around the world: Why do I need to know about China or should I care Asia Pacific: Hong Kong alone houses 55% of global about Investing Chinese equities ? - China's AUM in Chinese equity ETFs. representation in major equity indices ranges from 2% in the MSCI ACWI Index to 18% in the MSCI Emerging Europe: Most of the Chinese equity ETFs in Europe Markets Index.

4 In June 2013, MSCI announced it had are synthetically replicated. initiated a review of China A-Shares for potential inclusion in the MSCI Emerging Markets Index. If China Americas: With the exception of one ETF, all A-Shares were hypothetically included, China would Chinese equity ETFs listed in North America provide make up close to 30% of the MSCI Emerging Markets exposure to offshore-listed Chinese equities . Index. However, in our view, this is unlikely to transpire in the near term as there are still hurdles to inclusion There are numerous ways in which investors might namely (according to MSCI): (1) capital mobility, (2) choose to use Chinese equity ETFs (1) As a buy and the lack of alignment of the size of individual QFII quota hold investment; (2) To arbitrage the AH premium; (3). and the size and investment process of investors and (3) Sector rotation; etc. the lack of clarity on taxation rules . It is important that investors assess and understand the The further opening up of China's capital market and the risks associated with these ETFs at all times.

5 These risks internationalisation of the RMB are a trend that include ETF-specific structural risks, market risks and investors and ETF providers should watch closely. In currency risks as well as A-Share specific considerations particular, in July 2013, the CSRC announced it would regarding taxation and the potential for quota-related expand the RQFII scheme, which allows qualified premiums and discounts. institutional investors to invest directly in Chinese At the end of the report, we include 10 frequently asked securities, to London and Singapore. We expect that questions that we believe every investor should be able this will lead to the launch of RQFII ETFs in additional to answer before Investing in Chinese equity ETFs, countries outside of Hong Kong. including: What should be my thought process when I. Chinese companies listed in different markets are am deciding amongst Chinese equity ETF(s)? We classified under different share types/names.

6 They could provide an illustration outlining our recommended be classified as onshore or offshore Chinese equities ; thought process in answering this question. and then further subdivided into A-Shares, B-Shares, H- Shares, Red Chips, and P Chips, etc. As of today, there are over 50 country, sector, and strategy indices tracked by approximately 100 Chinese 2013 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, Morningstar ), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Certain information may be self-reported by the investment vehicle and not subject to independent verification.

7 Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use. Past performance is no guarantee of future results. Morningstar's Guide to Investing in 4. Chinese equities via ETFs July 2013. The ABC's (and H's and P's) of They are quoted in HKD and open to international investors. Note that many companies with H-Share listings Chinese Equity Investing also have A-Share listings. Red Chips (offshore): Issued by companies incorporated outside of China which trade on the Hong Kong Stock Exchange, controlled by organisations or enterprises that Defined in very general terms, Chinese equities are issued are owned by the state, provinces, or municipalities of the by companies doing business in the People's Republic of PRC. China (PRC). More granularly, Chinese companies listed in different markets are classified under different share P Chips (offshore): Issued by companies incorporated types/names, depending primarily on whether they are outside of China which trade on the Hong Kong Stock incorporated inside or outside of China.

8 Namely, these Exchange and satisfy the following criteria: classifications include A-Shares, B-Shares, H-Shares, Red The company is controlled by PRC individuals Chips, and P Chips. The company derives more than 80% of its revenue from 1. Total Market Capitalisation of China and Hong Kong Markets PRC. China A-Shares B-Shares A-Shares (Shanghai & Shenzhen) + B-Shares The company allocates more than 60% of its assets in (in RMB, billions) 21,122 159 21,281 PRC. (in USD, billions) 3,441 26 3,467. Note that the above are MSCI classifications which serve Hong Kong H-Shares Red Chips Mainland H-Shares Total as general guidelines. Investors may also encounter Private + Red Chips Hong references to L-Shares ( Chinese securities with listings on Enterprises + Mainland Kong the London Stock Exchange), N-Shares ( Chinese securities Private Enterprises with listings on the NYSE or NASDAQ) and S-Shares (in HKD, billions) 4,219 4,441 2,916 11,575 20,707 ( Chinese securities listed in Singapore).

9 Different index (in USD, billions) 544 573 376 1,492 2,670 providers may classify these slightly differently. For Source: Stock Exchange of Hong Kong, Morningstar Research (Data as of end-June 2013) example: A summary of each of these classifications is as follows: FTSE defines red chips and P Chips as stocks issued by those companies with over 50% of their revenue or A-Shares (onshore): Issued by companies incorporated in assets derived from or located within the PRC. (Note China which trade on the Shanghai and Shenzhen stock that FTSE began including P Chips in their Chinese equity exchanges. They are quoted in Renminbi (RMB) and only indices effective from 18 March 2013.). domestic Chinese investors and Qualified Foreign Institutional Investors (QFIIs) and RQFIIs (the R stands S&P considers criteria including the location of the firms'. for Renminbi) are able to invest directly in the A-Share headquarters, primary stock exchange listing, opinions market.

10 Of security analysts and investors, geographic sources of revenues, and the location of fixed assets or employees. B-Shares (onshore but open to foreign investors): Issued by companies incorporated in China which trade on the All these differences, among other specifics of the Shanghai and Shenzhen stock exchanges. They are quoted underlying index methodologies, lead to slight differences in foreign currencies (Shanghai: USD; Shenzhen: HKD) and in the composition of these providers' benchmarks. are open to foreign investors. However the size of this market is relatively small. H-Shares (offshore): Issued by companies incorporated in China which trade on the Hong Kong Stock Exchange. 2013 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, Morningstar ), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely.


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